When it comes to U.S. stocks, Increase trumps quality

These companies have all enjoyed robust sales growth in a U.S. economy that is below its boiling point, even as many facets disqualify some of these as quality stocks.
Investors are paying a premium for the luxury of earnings growth: $24 for each dollar of earnings per share expected over the next 12 months, compared to $20 for quality titles and $13 for high adjusted free-cash-flow yield equities, according to Goldman Sachs data.
“In an environment like we are in now – where nobody really cares what things are worth – you might underperform, but over time reality will set in,” said Sean O‘Hara, manager at Pacer Financial Inc. “It always does.”
Its subscriber growth continues to exceed estimates, and the stock has rocketed over 45 percent.

NEW YORK (Reuters) – U.S. investors are not rewarding companies for generating great earnings consistently, opting instead for a stockpicking strategy that might be called “growth at a high cost.”
Earlier this month, the Fed, as expected, said it would begin to undo some of those policies.

LUXURY OF GROWTH

The market was led by so-called “FANG” stocks – such as Facebook Inc (FB.O), Amazon.com Inc (AMZN.O), Netflix Inc (NFLX.O) and Google parent Alphabet Inc (GOOGL.O) – and also a little winner’s circle of lesser-known names such as Celgene Corp (CELG.O) and Equinix Inc (EQIX.O).

Investors are bracing to change.

“Given the high prices and complacency that currently prevail in the current market, however, my favorite safe stocks (such as Berkshire Hathaway (BRKa.N) and Mondelez (MDLZ.O)) don’t feel cheap, and my favourite cheap stocks (such as Hertz (HTZ.N) and Spirit Airlines (SAVE.O)) don’t feel safe.
The recent performance commentary of the fund said investors have been shunning company fundamentals.
In addition, it’s harder for investors to assess what an earnings report is currently saying. Technology giants, for example, derive more of their value these days from patents services and brand value.

Goldman Sachs’ global investment research unit included firms such as retailer Ross Stores Inc (ROST.O), pharmacist CVS Health Corp (CVS.N) and oil driller Schlumberger NV (SLB.N) in its high quality group earlier this year.
Part of this reason quality does not get the job done as well as it once did might be that more assets follow “quantitative” funds that rely on the very same statistics measuring quality, said Brian Hayes, equity strategist at Morgan Stanley & Co LLC (MS.N).
“When you find these enormous headlines on big investors and hedge funds throwing in the towel because they can not make sense of the current market, that is a indication that things are going to turn,” said Guggenheim Partners LLC global chief investment officer Scott Minerd.
“Historically, I’ve invested in high quality, safe stocks at great prices in addition to lower-quality ones at distressed prices,” Tilson wrote to investors.
O‘Hara said quality investments underperform when investors are willing to buy stocks without regard to their worth, and that markets have been supported by the U.S. Federal Reserve’s extraordinarily loose policies.

Netflix has had 12 straight quarters of negative free cash flow, and the company warned it might not find positive free cash flow “for several years” since it invests in original content such as the science-fiction drama “Stranger Things.”

Yet these companies have not been star performers.

This interest in quality stocks has whipsawed fund managers; Whitney Tilson said that he was shutting down his Kase Capital Management LLC hedge fund.

Put another way, discriminating investors who have chosen companies are being penalized.

Pacer Financial is one of a several investment companies betting that quality will matter.

High-quality stocks chosen for their strong balance sheets and steady earnings have appreciated just 12 percent this year, according to Goldman Sachs Group Inc (GS.N), while the broader S&P 500 . SPX benchmark index has returned 13.8 percent.

REVERSAL OF STIMULUS

Yet some supervisors are currently betting that markets that are complacent could be shaken in their zombie-like slumber and its backdrop of lower interest rates comes to a conclusion.